Attorney's Column
Court: Not All ‘Incorporated’ Provisions Of an Upstream Contract Flow to the Sub
By THOMAS H. WELBY, P.E., ESQ. and GREGORY J. SPAUN, ESQ.
This column has often written about issues that affect contractor/subcontractor relations because subcontracting is ubiquitous in the industry. One of the most important aspects of subcontracting is to ensure that all responsibilities and potential liabilities are properly flowed up or down so that an intermediate contractor is not left holding the proverbial bag.
A shorthand way of doing this is for the subcontract to incorporate other contractual documents (including an upstream, or prime, contract) by reference. An appellate court reminds us in the recent case of Cobleskill Stone Products v Merchants National Bonding that a simple shorthand incorporation by reference may not accomplish the flow up/flow down intended.
Background
In May 2018, JBS Dirt, Inc., entered into a contract to construct taxiways at the Sidney Municipal Airport in Delaware (NY) County. Defendant Merchants National Bonding issued a payment bond to JBS to guarantee payment to JBS’s subcontractors. Thirteen months later, JBS entered into a subcontract with Cobleskill Stone Products for Cobleskill to perform the paving scope of work for the project. The subcontract included, as an exhibit, a quote from Cobleskill indicating that its pricing was based on prevailing wage rates, and it provided the specifics of the formula upon which any increase was to be based. The subcontract also incorporated JBS’s prime contract in its entirety.
In July and August 2019, Cobleskill submitted payment requisitions to JBS, which included increases from the initial quote, as per the formula set forth in the estimate. JBS rejected those requisitions based on the language in the incorporated prime contract that prohibited escalation clauses on projects overseen by the Federal Aviation Administration. The back and forth between Cobleskill and JBS did not resolve the issue, and Cobleskill made a claim against Merchants under JBS’s payment bond—which it ultimately put into suit.
After discovery in the lawsuit, Cobleskill moved for summary judgment on its bond claim, arguing that it was entitled to the escalated price under the subcontract. Merchants opposed, citing the prohibition against escalation clauses contained in the prime contract. The motion court granted the motion and Merchants appealed.
Decision
The appellate court affirmed the motion court’s granting of Cobleskill’s motion for summary judgment. In doing so, the appellate court noted that Cobleskill’s quote with the escalation formula was included with the subcontract as one of the listed contract documents, and that the price increase it sought was in line with that formula. With Cobleskill’s burden met, the appellate court turned to whether Merchants introduced any evidence which could create an issue of fact sufficient to deny the motion. While Merchants did introduce evidence of the FAA’s prohibition against escalation clauses in the incorporated prime contract, the appellate court, citing well settled case law, held that this was insufficient to create an issue of fact sufficient to deny the motion because a subcontractor is only bound to the terms of such an incorporated prime contract which “relat[e] to the scope, quality, character and manner of the work to be performed by the subcontractor,” and not its pricing.
Comment
While the shorthand of general incorporation by reference provisions are seductive (they are short, easy to include, and purportedly all-encompassing), contractors must be warned that these provisions are ineffective to incorporate many of the provisions that are the most important to incorporate, such as the pricing provisions at issue here. Other provisions which will not flow down through a general incorporation by reference provision are the dispute resolution provisions; insurance provisions; specific record-keeping requirements (such as certified payrolls); indemnification requirements; and termination provisions, amongst others. Rather, specific references must be made for these provisions in order for them to carry over.
While subcontracts currently average well over 30 pages, and nobody relishes the thought of that number increasing to more than 40 pages, the Cobleskill court reminds us that the shorthand of incorporating a prime contract by reference is not the way to keep that number down. In subsequent contract disputes, contractors’ claims will stand or fall based on the documents they sign. In that regard, contractors would be well advised to consult with experienced construction counsel when drafting or negotiating contracts so that they can be sure that the provisions they wish to incorporate will actually make it over to the downstream contract. Otherwise, a contractor risks a gap in the obligations, which are flowed down, and may end up holding that empty bag.
P.S.—Before signing any contract, obtain (and read!) all incorporated documents.
About the author: Thomas H. Welby, an attorney and licensed professional engineer, is General Counsel to the Construction Industry Council of Westchester & Hudson Valley, Inc., and the Building Contractors Association, and is the Founder of and Senior Counsel to the law firm of Welby, Brady & Greenblatt, LLP. Gregory J. Spaun is General Counsel to the Queens and Bronx Building Association and an attorney and a partner with the firm, co-authors this series with Mr. Welby.